George Hosfield, CFA, discusses Ferguson Wellman's quarterly strategy titled, "Inflation's Flame Flickers," which addresses the narrow market leadership, the impact of higher interest rates on inflation and how assets are priced at this stage of the economic cycle.
George Hosfield, CFA, discusses the firm's quarterly strategy titled "Stalemate," which highlights the Fed's ongoing battle to tame inflation along with our views on the health of the banking industry and capital market expectations for the balance of the year.
Director and Chief Investment Officer George Hosfield, CFA, discusses the Fed raising interest rates, peaking inflation and our view on equities and volatility across all asset classes in our Investment Strategy titled, “Balancing Act.”
Someone once told me that the secret to a happy life is low expectations. While a melancholy motto, it aptly captures the mood of the current earnings season. The S&P 500 has rallied from the depths of January, and is now positive for the year - this despite earnings estimates dropping rather precipitously
by Shawn Narancich, CFAExecutive Vice President of Research
Awaiting Lift-Off
Following last week’s solid jobs report, a clear plurality of investors now expect the Federal Reserve to raise short-term interest rates next week. But once the Fed has achieved lift-off, what then? Amid ongoing dollar strength and falling energy prices, corporate profits have stagnated this year and economic growth remains pedestrian, causing concern about more of the same in 2016, but with less monetary accommodation along the way. We expect the path of Fed rate tightening to be gradual because inflation remains nearly non-existent. Even excluding food and fuel prices, so called “core inflation” also remains notably below the Fed’s 2 percent objective.
Mission Partly Accomplished
What we do have, and what is leading to the end of zero interest rate policy, is a state of relatively full employment. Although the labor force participation rate remains near decade low levels, the Fed rightfully sees its full employment mandate as having been achieved. In turn, we have seen stirrings of labor cost inflation, both statistically and anecdotally. The employment cost index is finally nearing 3 percent after having spent a prolonged stretch below that mark. Real life examples include fast food restaurants like McDonald’s and retailers Wal-Mart and TJ Maxx having to boost wage rates to keep employees; the degree to which labor inflation takes hold more broadly will be important to gauge, as this combined with the productivity of labor determine what we believe to be the single most enduring predictor of consumer price inflation – unit labor costs. Perhaps because of muted levels of capital spending later in the economic cycle, workers’ productivity has proven to be disappointing in recent quarters, increasing upward risk to this key measure. As the Yellen Fed achieves lift-off from zero percent interest rates, it will be closely tracking its labor force dashboard in helping to determine how fast and how high rates ultimately go.
OPEC Laissez-Faire
OPEC finished its latest and much anticipated meeting in Austria last Friday much like we expected, acceding to the current level of the 12-member cartel’s production, but apparently not making any plans to accommodate additional liftings from Iran once UN sanctions are lifted, as expected sometime early next year. While some thought OPEC would cut production, this outcome never seemed likely. Lead producer Saudi Arabia’s strategy has come into focus – keep oil prices low enough, long enough, to accommodate its recapture of market share and stimulate enough additional demand to tighten oil markets naturally. In essence, the cartel has ceased to act as one. By all accounts, the meeting was highly contentious and unusually long, the result of discord that saw members Venezuela, Nigeria and Ecuador argue unsuccessfully for reduced liftings.
Black Gold?
Oil prices fell on the news last Friday and have proceeded to breach late August support levels of $40/barrel. Not helping oil bulls’ cause is news this week that Iraqi production gains have boosted OPEC production to fresh three-year highs in November at the same time the El Nino weather phenomenon has warmed the Northern Hemisphere and squelched early season demand for heating oil, an important seasonal product of crude oil. These headwinds notwithstanding, we maintain our belief that oil markets will tighten as U.S. production continues to roll over, non-OPEC, ex-U.S. production stagnates, and oil demand again grows at a faster than anticipated clip. Barring a market share war within OPEC (one that would be fought with limited means given how little excess production capacity the cartel has), Saudi’s de facto strategy appears destined to succeed. We see modest levels of oversupply morphing into undersupply as 2016 progresses. After all, the following adage holds – the best cure for low oil prices is low oil prices.
Our Takeaways from the Week
by Shawn Narancich, CFAExecutive Vice President of Research
Retailing Blues
Earnings season has all but wrapped up for another quarter, but department store retailers are adding a problematic book-end to a quarter that has generally come in ahead of expectations. Flat third quarter earnings were weighed down by widespread losses in energy and dampened again by the stronger dollar, factors that many investors thought would spare U.S. centric retailers. Following Wal-Mart’s surprisingly weak earnings outlook in October, both Macy’s and Nordstrom came to the earnings confessional this week to report weaker than expected sales and substantially reduced profit forecasts. For Macy’s, its red star seems to be falling, as elevated inventories are forecast to weigh on margins for the company’s most important holiday sales quarter. Despite recent evidence of elevated merchandise levels in traditional retail channels, the subsequent 15-20 percent declines in both retailers’ share prices speak to the traffic challenges afflicting both Nordstrom and Macy’s. Investors long retailing stocks will hope for better news from home improvement, off-price, and specialty retailers next week.
Sales Falling Flat?
Amid increasing concerns about U.S. retailing, news that October retail sales barely budged cast a further shadow on the industry. In our opinion, weakness for select retailers reporting quarterly numbers speaks more to their distribution strategies and product mix than to any deeper concerns about the health of U.S. consumers. Shoppers are buying more of what they want and need online at Amazon.com, disadvantaging traditional bricks-and-mortar retailers that lack the cars, footwear, and food that consumers still want to see and trial firsthand before they buy. Also at work are the weather and the dollar. A mild fall has hurt department store retailers’ apparel sales and the strong dollar has deterred foreign visitors from taking American shopping sprees. Notwithstanding company specific retailing challenges, we continue to believe that a healthy job market, low gas prices, and low interest rates support domestic consumption and will be a tailwind for the U.S. economy.
Oil -- Down but not Out
In addition to the hit that retailers took this week, energy stocks again took it on the chin as oil prices retest August lows. Refineries are going through what’s called the turnaround season, a time of reduced product output that coincides with a change in product emphasis from summer gasoline to winter heating oil. Refinery throughput slows and with it, crude demand. As investors fret about recent US inventory builds, we would observe that seasonal factors are at play that obscure the tightening of oil markets – tightening that coincides with falling U.S. production and flattening OPEC production. We don’t expect OPEC to cut production at its December 4 ministerial meeting, but we do believe it will acknowledge that markets are coming back into balance and accede to the cartel’s current level of output. With fuel demand continuing to grow at healthy levels and global supply flattening, the slack in oil markets is disappearing. We are bullish on oil and look forward to higher prices ahead.
Our Takeaways from the Week
by Shawn Narancich, CFAExecutive Vice President of Research
Decoupling
With the holiday season in full swing and U.S. investors rejoicing about another year of solid U.S. equity returns, most international investors may be forgiven for feeling like they are getting a lump of coal in their Christmas stocking. In an increasingly decoupled global economy, where China’s growth is slowing and Europe and Japan teeter on the brink of recession, 11 percent returns domestically reflect, in part, the increasingly attractive growth profile of the U.S. economy. What’s surprising is the fact that China’s stock market has risen over 30 percent so far this year, helping buoy emerging market equity returns in a year where stocks have fallen in most foreign markets. Providing better investor access to mainland Chinese equity markets (through linking the Hong Kong and Chinese markets) has helped stimulate investor demand, but the flow of economic data out of the Red Giant remains rather discouraging. Slowing industrial production growth, weaker retail sales, and moribund manufacturing activity all speak to the challenges that Chinese policy makers confront in transitioning the world’s second largest economy from an investment led juggernaut to one better balanced by consumption.
Leading the Way
In contrast, the U.S. economy is moving full speed ahead. The November retail sales growth that came in at the high end of estimates reaffirms our thesis of a healthier U.S. consumer boosted by healthy job gains, rising home prices and the falling price of oil. Healthy retail sales data bely the 11 percent sales decline over the long Thanksgiving Day weekend, indicating that the weak sales numbers were more a function of an earlier start to the holiday selling season. With government spending having apparently bottomed and capital spending on the rise, the error of estimates for Q4 GDP is once again higher.
Crude Thoughts
All of which brings us to the topic that seems to be on everyone’s mind nowadays – oil. Now down 46 percent since June, U.S. black gold is far from it at the moment. Yet we continue to believe that the fundamentals of oil aren’t as bad as the price implies. Developed economy inventories are near five-year averages, global demand continues to grow and, most importantly, because of oil’s correlation with economic growth, GDP globally continues to expand in a world of accommodative monetary policy. Contrast today’s environment with 2008, when oil plummeted over 70 percent in eight months, a washout that coincided with consumer price shocks from $4.40/gallon gas and a global economy on the verge of collapse. The best cure for low oil prices is low oil prices, and at today’s level of around $60/barrel, we expect global petroleum exploration and development spending to fall by 25 percent or more in 2015, sowing the seeds for tighter markets and higher prices.
Indeed, evidence of the supply response to come is already upon us. Lower prices are reducing oil companies’ cash flow, leaving them with less money to reinvest in new wells. We are just beginning to see U.S. shale producers announce their 2015 capital budgets and, so far, the anecdotes support our contention that investment levels will drop dramatically. Indeed, November’s new U.S. well permits number, down 45 percent sequentially, offers investors a taste of the supply response to come. Conoco has announced a 20 percent drop in its capital spending and small independent producer Oasis is cutting its 2015 cap ex budget by 44 percent. Dozens of other independent U.S. producers, those responsible for the domestic energy boom of recent years and which are largely responsible for doubling U.S. production over the past six years, will come to the confessional between now and the end of January.
With less money being expended to replenish reserves from shale wells that deplete up to 50 percent of recoverable reserves in the first two years of production, we expect the oil markets to tighten faster than investors currently believe. We would observe that the incremental U.S. liftings that have driven production growth globally are of much shorter duration than the marginal production of 2008 from the Gulf of Mexico. Deepwater projects can take 5-10 years to produce first oil and, when it finally comes, wells under extreme pressure miles below the seafloor produce at persistently high flow rates for project lives that can last up to 30 years. The point is that supply elasticity is likely to bite much faster this time around and, even with the production backdrop pre-shale, low prices didn’t last for long in 2009. So in this festive season, be thankful for the boost to disposable income that today’s low oil prices provide, but don’t expect them to last.
Our Takeaways from the Week
